EXAMPLE 3- DROPPING UNPROFITABLE SEGMENTS

Bed & Bath, a retailing company, has two departments, Hardware and Linens. The companys most recent monthly contribution format income statement follows:

Department

Total Hardware Linens

Sales $4,000,000 3,000,000 1,000,000

Variable costs 1,300,000 900,000 400,000

Fixed expenses 2,200,000 1,400,000 800,000

Net Operating Income (loss) $500,000 $700,000 $(200,000) A study indicates that $340,000 of the fixed expenses being charged to Linens are sunk costs or allocated costs that will continue even if the Linens Department is dropped. In addition, the elimination of the Linens Department will result in a 10% decrease in the sales of the Hardware Department.

Required:

If the Linens Department is dropped, what will be the effect on the net operating income of the company as a whole?